Introduction

The accounting method known as depreciation, depletion, and amortisation (DD&A) is used by
businesses to match an asset's cost to its revenue over its economic useful life. Generally, accrual
accounting is used for this purpose.

By using DD&A, a business can disperse the costs associated with purchasing a fixed asset across the
course of the asset's useful life. Amortisation is applicable to intangible assets, whereas depreciation is
relevant to tangible assets, sometimes known as long-term assets.

In contrast, depletion is the term used to describe natural resources like oil, gas, and other natural extracts.
It permits the costs associated with resource exploration and extraction to be distributed over the
resource's eventual consumption or exhaustion.

Depreciation
The planned gradual reduction in the recorded value of a tangible asset over its useful life is referred to as
depreciation. Using depreciation is intended to spread expense recognition for fixed assets over the period
when a business expects to earn revenue from those assets. This refers to prorating a tangible asset’s cost
over its expected lifespan. Tangible assets include physical assets like machinery, equipment, vehicles,
and buildings.

Suppose a company purchases a machine for $300,000. The company expects the machine to have a
useful life of 20 years, and after that, it can be sold for $30,000 (Salvage Value). Using the straight-line
depreciation method, the annual depreciation would be

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 − 𝑆𝑎𝑙𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒

𝑈𝑆𝑒𝑓𝑢𝑙 𝐿𝑖𝑓𝑒

$300,000−$30,000
= 20

=$13,500

Company Depreciation for each year is $13,500

Depletion
The accrual accounting method known as "depletion" is frequently applied in the industries that extract
natural resources, including mining, oil, and lumber, among others. It refers to the actual physical
reduction of a natural resource.

Suppose an Oil production company spends $800,000 to develop production well fields. It estimates that
there are 400,000 barrels oil. The depletion rate per barrels of oil production would be:

𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡
𝑇𝑜𝑡𝑎𝑙 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑂𝑖𝑙 (𝑏𝑎𝑟𝑟𝑒𝑙𝑠

$800,000
= 400,000

=$2 per barrel

IF the oil Company produces $30,000 barrels of oil for first year, the Depletion would be $60,000
(30,000*$2)

Amortization
A similar idea underlies amortization, which is used to account for an intangible asset's use over time.
Amortization, in the context of the oil and gas sector, refers more widely to the process of continuously
deducting the cost of properties, wells, and equipment from the price of the produced oil and gas. This is
applied to intangible assets such as software expenses, copyrights, patents, and goodwill. Like real goods,
these assets have a finite lifespan and gradually lose value. These assets have a variable cost during the
course of their economic or legal useful lives.

Suppose an Oil Company buys a software patent for $200,000. The patent has a legal lifespan of 20 years.
Using straight-line amortization, the annual amortization would be:

𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡
𝐿𝑒𝑔𝑎𝑙 𝐿𝑖𝑓𝑒𝑠𝑝𝑎𝑛

$200,000
= 20

=$10,000 per year

So, the company amortization expense would be $10,000 for per year
Depreciation calculation Methods:
Depreciation methods include

• Straight-Line Depreciation Method

• Double Declining Balance Depreciation Method
• Sum-of-the-Years' Digits Depreciation (SYD) Method

Straight-Line Depreciation Method

The straight-line method calculates an average decline in value over a period. This is the most common
method and the simplest way to calculate depreciation. In straight-line depreciation, the expense amount
is the same every year over the useful life of the asset. You can use the straight-line method on assets such
as vehicles, office furniture, equipment, and buildings.

Cost of Machine−Salage Value

Depreciation Expense =
USeful Life

Suppose an oil company machine cost $50,000 for 8 years and salvage value $0

Year 1 2 3 4 5 6 7 8
Value $50,000 $43,750 $37,500 $31,250 $25,000 $18,750 $12,50 $6250
0
Depreciation $6250 $6250 $6250 $6250 $6250 $6250 $6250 $6250

STRAIGHT LINE DEPRECIATION

$50,000

$43,750

$37,500

$31,250

$25,000

$18,750

$12,500

$6,250

1 2 3 4 5 6 7 8
Double Declining Balance Depreciation Method

Double-declining-balance depreciation results in a larger amount expensed in the earlier years as opposed
to the later years of an asset’s useful life. The method reflects the fact that assets are typically more
productive in their early years than in their later years – also, the practical fact that any asset (think of
buying a car) loses more of its value in the first few years of its use. With the double-declining-balance
method, the depreciation factor is 2x that of the straight-line expense method.

Consider a property costs $50,000, with an estimated useful life of 8 years and a $5,000 salvage value and
to calculate the double-declining balance depreciation

100%
Depreciation rate = ×2
8

= 25%

Year 1 2 3 4 5 6 7 8
Value $50,000 $37,500 $28,125 $21,094 $15,820 $11,865 $8,899 $6,674

Depreciation $12,500 $9,375 $7031 $5,274 $3,955 $2,966 $2,225 $1,668

Ending Value $37,500 $28,125 $21,094 $15,820 $11,865 $8,899 $6,674 $5,006

Sum-of-the-Years' Digits Depreciation (SYD) Method

The sum-of-the-years'-digits method (SYD) less aggressively than the declining balance method. Annual
depreciation is derived using the total of the number of years of the asset's useful life. The SYD
depreciation equation is more appropriate than the straight-line calculation if an asset loses value more
quickly, or has a greater production capacity, during its earlier years.

Remaining Life
Depreciation Expense = Sum of the Years Digits × (Cost − Salvage Value)

Consider a piece of equipment that costs $25,000 and has an estimated useful life of 8 years and a $0
salvage value. To calculate the sum-of-the-years-digits depreciation,

Sum of the year digits = 8+7+6+5+4+3+2+1 = 36

 Year 1 2 3 4 5 6 7 8
Remaining Life 8 7 6 5 4 3 2 1
Value $50,000 $38,889 $29,667 $21,191 $14,127 $8,476 $4,238 $1,413

Depreciation $11,111 $9,222 $8,476 $7,064 $5,651 $4,238 $2,825 $1,413

Ending Value $38,889 $29,667 $21,191 $14,127 $8,476 $4,238 $1,413 $0